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Mortgage REIT ETFs: Overlooked Winners

Over the past few months, mortgage REITs (mREITs) had been under immense pressure due to market concerns relating to the Fed’s tightening of monetary policy. The stress situation resulted in soaring mortgage rates and rising yields.

Both 30-year and 15-year mortgage rates climbed to their two-year highs of 4.58% and 3.60%, respectively, on August 22. Similarly the yield on 10-year Treasury note climbed to a high of 3% in early September from a low of 1.6% in May (read: REIT ETFs Rise as Treasury Yields Finally Tumble).

This trend seems reversing with the Fed keeping its stimulus intact. The continued purchase of bonds would keep long-term loan rates low to encourage borrowing. Lower long-term rates coupled with the short-term ultra-low rates would increase the spread, thereby boosting profit margins for the mREIT space.

This is particularly true as these REITs invest in mortgage-backed securities and use short-term debt for financing their purchases, making money from the spread (read: Mortgage REIT ETFs: Is The Plunge Over?).

In such a backdrop, mREITs have bounced up from their lows and are moving higher over the past two weeks. In fact, the mREIT ETFs have outpaced the broader market following the Fed’s no taper announcement, suggesting that the worst might be over for the space.

Investors should also note that mREITs pay higher yields in the equity world due to their combination of leverage and real estate holdings. Being REITs, these securities must pay out at least 90% of their earnings to holders for a favorable tax treatment. With this focus, many mREITs often pay out double-digit yields, handily crushing broad Treasury bond markets and other dividend payers.

Given a bullish outlook at least for the short term, investors could take a look at the mREIT ETFs space and enjoy a nice bounce back in the coming weeks. Below, we have highlighted two funds that could continue to offer price appreciation to investors as long as the Fed does not taper its stimulus (see: all the Real Estate ETFs here).

This is the most popular mREIT ETF on the market with roughly $1.1 billion in AUM and just under 1.5 million shares a day in average volume. The ETF tracks the FTSE NAREIT All Mortgage Capped Index and holds 34 securities in its basket.

The product is heavily concentrated on the top two firms – Annaly Capital (NLY) and American Capital Agency (AGNC) – which collectively make up for 32% share. Other securities hold less than 7.3% share. The product has a certain tilt toward the small caps as these account for more than half of the portfolio.

The product charges investors 48 basis points a year in fees. Obviously, the yield is the real focus of this fund as the 30-Day SEC payout comes in at just under 14% (read: No Taper? No Problem for These Dividend ETFs). The ETF added over 4% over the last 10 trading sessions but is down 5.35% in the year-to-date (:YTD) time frame.

This fund follows the Market Vectors Global Mortgage REITs Index and holds 26 securities in its basket. The ETF trades in average volumes of more than 88,000 shares per day and manages an asset base of $101.3 million. Investors need to pay a fee of 41 basis points annually for this fund, so it is a middle-of-the-road ETF in terms of expenses.

Here again, the product is heavily weighted toward the top two firms – NLY and AGNC – at 29% combined. Other firms hold less than 6% of MORT. Similar to its iShares counterparts, small caps dominate the fund’s portfolio with 61% share while large (16%) and mid (23%) caps account for the rest (see more in the Zacks ETF Center).

Yields are impressive in this ETF as well, as the 30 Day SEC payout comes in at 10.68%. The fund has beaten out REM from a price perspective, as the ETF gained nearly 4.3% over the past 10 days and 0.50% YTD.

Bottom Line

Though the surprise move by Ben Bernanke has raised new hopes into this corner of investing, investors should take some caution as the next round of taper talk is seemingly underway.